Telecommunications Reform— How to Succeed

Telecommunications Reform— How to Succeed

Privatesector
P
U
B
L
I
C
P
O
L
I
C
Y
F
O
R
T
H
E
Note No. 130
October 1997
Telecommunications Reform—
How to Succeed
Björn Wellenius
Today, more than sixty emerging economies—twenty-five in Sub-Saharan Africa alone—are
at some stage of transformation from state telecommunications monopolies to private-led,
competitive markets. When well done, this reform can be a positive-sum game in which all
stakeholders gain—customers, existing and new operators, employees, domestic and foreign
investors, and the government. Faster growth, better and new services, lower costs, and,
eventually, lower prices follow. This Note outlines the key ingredients of successful reform.
Get support at the top
Reform is most likely to succeed if it is led at
the highest level of political authority. This is
usually the head of government, who then allocates responsibility for the reform to a single
person with direct access to senior government
officials, freedom to cut red tape, and resources
to assemble a small support team and hire the
necessary experts. Such was the case in the
privatization of Mexico’s telecommunications
company, TELMEX. The president announced
the reform in August 1989, appointed the minister of finance chairman of the board and gave
him overall responsibility for the privatization,
and handed over the chief executive’s job to
an experienced public administrator with a clear
reform mandate. Privatization was completed
in December 1990. By contrast, Brazil’s attempts
at reform from the early 1980s did not muster
the necessary political muscle. Not until 1997
has real progress been made.
Sort out conflicting objectives early
The primary purpose of reform is to get
consumers more, better, new, and less costly
services. Pressures from interest groups—incumbents who want ongoing protection, new
entrants seeking special deals, treasury officials
expecting to use sale revenues to reduce budget
deficits, financial advisers earning success fees
tied to transaction prices—can steer reform off
this track. In particular, sale strategies that drive
up the prices paid for existing companies or
new licenses can hold down growth, reduce
the funding available to invest in these companies, or result in high tariffs.
For example, convinced that the six-year longdistance monopoly granted to TELMEX in 1990
had led to high consumer prices and slower
growth than would have happened under competition, the government in 1996 chose to forgo
the high fees it could have obtained by tendering one or two new licenses and instead opted
for unrestricted entry. In India, exorbitant prices
bid for second fixed operator licenses in 1996
combined with modest revenue projections
(from an overall low-income population) is making it difficult to raise debt financing for investment. In Brazil, the consortium that won the
cellular license in São Paulo in 1997 with a
US$2.5 billion bid—four times the government’s
asking price and 60 percent more than the second-highest bid—is likely to pass on the cost to
customers through much higher tariffs than those
proposed by rival bidders. By contrast, the
government of Bolivia privatized ENTEL in 1996
by issuing new shares for which the winning
The World Bank Group ▪ Finance, Private Sector, and Infrastructure Network
Telecommunications Reform—How to Succeed
bidder paid US$600 million, immediately available for investment in the company.
Sale strategies that place less emphasis on cash
up front can, moreover, yield substantially more
cash to the government later. For example,
awarding a cellular license to the bidder that
offers the largest build-out plan—rather than
the one offering the highest license fee—can
increase tax revenue for years to come by creating more business. And initially selling only
the minimum number of government shares
needed for effective transfer of control of the
state company to the new owners (usually 20
to 30 percent) allows the government to float
the balance later and obtain much higher prices,
once the company appreciates under private
management. In the privatization of TELMEX,
for example, the government initially sold 20
percent of the shares to a strategic investor in
1990 for US$1.8 billion, then sold 31 percent
more through public offerings in 1991 and 1992
for US$4.5 billion—70 percent more per share.
Set clear policies and procedures
The business offered to investors must be
clearly defined in the laws, regulations, and
main transaction documents (licenses, contracts
of sale). The most critical policy issues relate
to pricing, competition, and interconnection.
In pricing, governments must bite the bullet
early and rebalance tariffs. The price an operator is allowed to charge its customers is the
most important determinant of profitability and
ability to finance growth. Existing tariffs are
often way out of line with costs. Including rebalancing plans in the licenses or contracts has
tended to delay further reforms, as the new
owners avoid the public fallout from raising
some prices yet later expect the licensing of
competitors to be delayed because tariffs remain unbalanced. To set new tariff structures,
though, calculating the actual costs of each
operator is seldom a viable method. Rather,
tariffs observed in competitive markets probably offer the best guidance on efficient prices.
Although some cost elements (labor, land,
taxes) vary considerably among countries, the
main costs (equipment, capital) are determined
in global markets and thus international benchmarks are relevant. As the market becomes
more competitive, pricing can be increasingly
left to the operators.
The interconnection obligation of the dominant
operators, the principles under which terms of
interconnection will be negotiated, and the process and timetable for a regulatory decision if
the parties fail to reach agreement must be
clearly spelled out. A new operator’s ability to
reach (and be reached by) customers of the
existing operator and to use parts of existing
networks under reasonable technical and price
terms rather than building complete new facilities plays a big part in determining not only its
own viability but also the economic efficiency
of the sector overall. In Poland, failure to sort
out interconnection with the incumbent meant
that of some 200 licenses issued to independent operators since 1990, only about twelve
were in use in 1996. Licensees cited the main
impediments as unfavorable terms for sharing
revenues with the dominant state operator, limited access to its network, slow negotiation of
interconnection agreements, and a prohibition
on setting up their own transmission facilities.
Reforms should follow clearly defined processes
that are open to participation and review by all
interested parties. The public should be kept
informed. Market mechanisms, not individual
negotiations, should be used to select partners
and determine the right sale prices. And the
award of licenses and contracts should strictly
adhere to the evaluation criteria announced at
the outset. Once a window of political opportunity for reform opens, time is of the essence—
but should not be used as an excuse to cut
corners or strike deals behind closed doors.
Clear rules and processes must also apply to
the regulatory function. The locus and functions
of regulatory authority as well as the basic procedures that will govern its relationships with
operators and customers must be defined, preferably by law. That does not mean that a full
regulatory capability must be in place before
TABLE 1
FASTER GROWTH IN OPEN, PRIVATIZED MARKETS
Annual percentage growth in main telephone lines
major reform steps can be undertaken. Initial
regulatory decisions can be written into licenses
and contracts of sale. A core decisionmaking
capability in the form of a commission, say, and
a secretariat with processing capability, supported by outsourcing of expertise, can deal with
whatever is essential in the first two or three
years, such as issuing licenses, managing conflicting demands on the radio spectrum, and
resolving interconnection disagreements. Other
areas of competence can be gradually developed as needed. Chances are that successive
problems will arise, peak, and then decline to a
low simmer so that a permanent, comprehensive in-house capability may never be needed.
Moreover, in most emerging economies, anything beyond a minimalistic regulatory institution is not feasible.
Open all markets to competition
Without competition, the benefits from increased
private participation will not be fully realized.
In Latin America, for example, countries that
granted monopoly privileges of six to ten years
to the privatized state enterprises saw connections grow at 1.5 times the rate achieved under
state monopolies but only half the rate in Chile,
where the government retained the right to issue competing licenses at any time (table 1).
Rural areas, too, can become an attractive business under liberal entry and pricing policies. In
Chile, government subsidies equivalent to less
than 0.5 percent of total telecommunications
revenue, allocated through competitive bidding
in 1995, mobilized twenty times as much private investment to extend basic telephone access
to rural areas. The program brought service to
about a third of the rural population lacking it.
Contrary to views often expressed by financial
advisers, investors are not opposed to competition—as long as they are not also burdened
with regulatory uncertainty, unrealistic service
obligations, and rigid tariffs and employment
rules. This is true even in small, low-income
markets. Ghana Telecom was successfully
privatized in late 1996 at the same time that a
license was awarded for a second full-service
1984–89
1989–94
Brazil, Colombia,
Ecuador, Peru, Uruguay
7.0
7.8
Argentina, Mexico, Venezuela
6.7
11.3
Chile
6.6
20.5
state monopolies
privatized monopolies
privatized open markets
Source: Pyramid Research (1996) and World Bank.
national operator and three other cellular companies were already in place—and the price
per line was similar to that paid for the monopoly in neighboring Côte d’Ivoire. But lack
of clarity regarding competition policy does
drive investors away. Partial privatization in
1996 of Svyazinvest, the Russian holding of 85
regional telecommunications companies, failed
shortly before closing when the winning bidder realized the government did not intend to
grant Svyazinvest a license to build its own
long-distance network.
Enhance credibility and stability
Even if a government gets all the policies, rules,
and procedures right, operators and investors
will come and stay only if they believe that the
government will stay the course. Governments
can do several things to enhance credibility
and stability. To safeguard reforms against political changes, governments should develop
them with the support of major stakeholders—
various branches of government, public and
private sector users, chambers of commerce,
consumer groups, large enterprises (including
state-owned firms) that could become alternative network providers, local investors and
banks, and the staff and management of existing operating companies.
In emerging economies, most with strong
growth potential, the concerns of labor can in
fact be readily accommodated. Most workers
Telecommunications Reform—How to Succeed
Viewpoint is an open
forum intended to
encourage dissemination of and debate on
ideas, innovations, and
best practices for expanding the private
sector. The views published are those of the
authors and should not
be attributed to the
World Bank or any of
its affiliated organizations. Nor do any of the
conclusions represent
official policy of the
World Bank or of its
Executive Directors
or the countries they
represent.
To order additional
copies please call
202-458-1111 or contact
Suzanne Smith, editor,
Room F6P-188,
The World Bank,
1818 H Street, NW,
Washington, D.C. 20433,
or Internet address
[email protected].
The series is also
available on-line
(www.worldbank.org/
html/fpd/notes/
notelist.html).
Printed on recycled
paper.
stand to gain from higher salaries, improved
career prospects, and new opportunities as
employees or entrepreneurs in a rapidly expanding market. Growth allows major gains in
labor productivity with little reduction in personnel. As Ghana Telecom prepared to privatize in 1996, some 500 workers (14 percent of
the combined telecommunications and postal
workforce) agreed to leave with severance packages that cost the government less than 3 percent of the initial proceeds from privatization.
After privatization, potential labor problems
largely disappeared following management
commitment that there would be no forced redundancies, introduction of training programs,
and expected growth. By contrast, labor unions
whose concerns—and political clout—had been
ignored brought to a halt Sri Lanka’s reform
program in the mid-1980s. In the restructuring
of state telecommunications enterprises in Latin
America, an additional enticement has been offered—employee stock option plans that transfer about 5 percent of shares to employees on
favorable terms.
Essential for reducing investor risk is limiting
the opportunity for discretionary government
or regulatory intervention in business, especially in the early years. In Uganda, initial decisions on tariffs, service obligations, and
default interconnection terms are being written into licenses and contracts (as was also done
in Ghana). Numbers that will remain firm for,
say, five years—subject if necessary to automatic adjustment, based on simple formulas,
for inflation, foreign exchange, or other factors—are more effective at reducing risk than
are rules for calculating these numbers.
Telecommunications reforms gain credibility
when coupled with broader programs in which
the government has a large stake. The privatization of ENTel in Argentina was the flagship
of President Menem’s multisectoral public enterprise reform program in the early 1990s, and
everyone knew that a failure by the government to stick to the rules it had set for telecommunications would have undermined the
whole program.
Investors, operators, and customers will be reassured by a telecommunications law that establishes broad principles and rules governing
the sector. A law with a narrower objective,
however, such as establishing a regulatory authority, may suffice. The timing of amending
or replacing a dated law must weigh the potential delays and political cost.
Anchoring key elements of reform in international frameworks also adds credibility. World
Trade Organization (WTO) member countries
that subscribe to the telecommunications agreement of 1997 enter a binding international commitment to implement aspects of their own
reform targets, abide by a common set of regulatory principles, and recognize the WTO as
an instance of intergovernmental appeal. All
this is likely to provide comfort to investors
worried about regulatory risk. Similarly, loans,
credits, and guarantees from multilateral agencies such as the World Bank Group involve
government obligations that can be tailored to
help offset risks such as failure of the government to abide by the terms of licenses (on pricing, for example) or ensure access to foreign
exchange for debt service or dividend payments. A US$90 million investment by the International Finance Corporation and the European
Bank for Reconstruction and Development in
1993 in the Hungarian state telecommunications company mobilized US$1.2 billion in foreign funds at the time of privatization.
Conclusion
Major transactions such as a privatization or the
issuance of new licenses tend to drive the reform agenda, but change continues well beyond
these transactions. Following the rules and honoring commitments helps consolidate an environment for sustainable growth. Also critical is
to build a regulatory capability to suit changing
needs, take every opportunity to enhance competition, and address any persistent gaps between development and commercial objectives.
Björn Wellenius, Telecommunications Adviser,
Telecommunications and Informatics Division